05/08/2013

Director Primacy at the Lowell Milken Institute

Herewith the text of remarks I gave yesterday to a gathering at UCLAW's Lowell Milken Institute:

In the US, corporate governance traditionally has been
board-centric. Section 141(a) of the Delaware General Corporation Law commands
that “The business and affairs of every corporation organized under this
chapter shall be managed by or under the direction of a board of directors,
except as may be otherwise provided in this chapter or in its certificate of
incorporation.” The drafters of the Model Business Corporation Act tell us that
the corporation code of every state but one have some
such formulation. I call this the director primacy model of corporate
governance. Other call it the board-centric model. In
retrospect, if I had it to do over again, I would too.

Why is director primacy almost universally enshrined in
corporate statutes? Why not shareholder primacy, in which management power is
vested in the shareholders, who own the corporation? Alternatively, why not
managerialism, in which management authority is vested in the Chief Executive
Officer (CEO) or an executive committee of top management?

Those are the questions to which the bulk of my scholarship
has been devoted for the last 15 years or so.

I set out not to reform the statutory allocation of power,
but simply to understand it. As it turned out, however, the analysis ended up
having strong normative implications.

In particular, I’ve spent a considerable amount of time debating
the merits of shareholder activism. As you likely know, shareholder activists
have already achieved considerable results. Majority voting, say on pay, board declassifications,
proxy expense reimbursement, and proxy access bylaws are just the most
prominent legal changes they have affected.

The most important question in corporate governance today
thus is finding the endpoint of the shareholder empowerment movement. Is there
a balance that is both politically feasible and theoretically sound?

I am pleased to report that The Lowell Milken Institute has
authorized me to organize a conference at UCLA Law in April 2014 that will
bring together prominent corporate law scholars to discuss the central question
of corporate governance; i.e., “who decides?” The focus will be on the changing
dynamics in both law and practice that have significantly empowered
shareholders.

I plan to invite scholars working in all three of the major
models of corporate governance currently in widespread use in the corporate
legal literature; namely, director primacy, team production, and shareholder
primacy.

Director primacy is the model I have developed over the last
ten years or so. It attempts to both explain and defend the broad grant of
authority to boards of directors that is at the heart of American corporate
law. It argues that this grant of authority is essential to ameliorating the
informational demands a large corporation faces. The grant of authority,
however, creates the potential for abuse of that authority, creating a need for
accountability mechanisms to limit such abuses. The tradeoff between authority
and accountability is at the heart of corporate law. I propose that a
presumption should generally favor authority, and therefore I oppose most
proposals to increase shareholder power.

Director primacy has been well received as a model of
corporate governance. And I have been recognized as “the leading proponent of
the director primacy view,” to quote J.W. Verret,
Treasury, Inc.: How the Bailout Reshapes Corporate Theory and Practice, 27 Yale
J. on Reg. 283, 321 (2010).

To be sure, director primacy has its critics. Some see it as
normatively unattractive, while others see it as lacking descriptive power. A
leading competitor to director primacy is the team production theory of
Margaret Blair and Lynn Stout. Like director primacy, team production theory
defends the broad grant of authority to boards. However, it draws upon a
different theoretical framework in doing so. Although team production theorists
agree with me on the desirability of granting significant authority to boards,
they disagree on the proper ultimate aims of the board in exercising that
authority. I believe boards should focus on maximizing the value of the
corporation for shareholders. Team production theorists believe boards should
focus on maximizing the net value created for all corporate constituents
collectively.

More importantly, director primacy is strongly opposed by
those scholars who adhere to shareholder primacy, with Lucian Bebchuk as the
most prominent example. Shareholder primacy theorists contend not only that
shareholders are the principals on whose behalf corporate governance is
organized, but also that shareholders do (and should) exercise ultimate control
of the corporate enterprise. Hence, for example, shareholder primacy assumes shareholder voting rights that are both exclusive and
strong.

The debate between these models is widely recognized as
having considerable importance for our understanding of corporate law and
governance. Faith Stevelman, for example, notes that
“[t]he competing claims of ‘shareholder primacy’ and
‘director primacy. go back to the early beginnings of
corporate law.” Faith Stevelman, Globalization and
Corporate Social Responsibility: Challenges for the Academy, Future Lawyers,
and Corporate Law, 53 N.Y. L. Sch. L. Rev. 817, 841 (2008/2009).

The choice between shareholder and director primacy is most
obvious relevant to proposals to empower shareholders, such as say on pay,
proxy access, and majority voting. At present, as Gordon Smith notes, “[d]espite the recent moves
facilitating shareholder empowerment with respect to director elections, both
Delaware and the SEC continue to rely on ‘director primacy’ as a foundational
principle of corporate governance.” D. Gordon Smith, Private Ordering With
Shareholder Bylaws, 80 Fordham L. Rev. 125, 170 (2011). As advocates of
shareholder empowerment continue to press their claims with respect to other
legal issues, however, the pressure on Delaware and the SEC to chose between
shareholder and director primacy will become even more intense.

The conference therefore will be devoted to using these
models to explore the ongoing question of shareholder empowerment.

Comments

Director Primacy at the Lowell Milken Institute

Herewith the text of remarks I gave yesterday to a gathering at UCLAW's Lowell Milken Institute:

In the US, corporate governance traditionally has been
board-centric. Section 141(a) of the Delaware General Corporation Law commands
that “The business and affairs of every corporation organized under this
chapter shall be managed by or under the direction of a board of directors,
except as may be otherwise provided in this chapter or in its certificate of
incorporation.” The drafters of the Model Business Corporation Act tell us that
the corporation code of every state but one have some
such formulation. I call this the director primacy model of corporate
governance. Other call it the board-centric model. In
retrospect, if I had it to do over again, I would too.

Why is director primacy almost universally enshrined in
corporate statutes? Why not shareholder primacy, in which management power is
vested in the shareholders, who own the corporation? Alternatively, why not
managerialism, in which management authority is vested in the Chief Executive
Officer (CEO) or an executive committee of top management?

Those are the questions to which the bulk of my scholarship
has been devoted for the last 15 years or so.

I set out not to reform the statutory allocation of power,
but simply to understand it. As it turned out, however, the analysis ended up
having strong normative implications.

In particular, I’ve spent a considerable amount of time debating
the merits of shareholder activism. As you likely know, shareholder activists
have already achieved considerable results. Majority voting, say on pay, board declassifications,
proxy expense reimbursement, and proxy access bylaws are just the most
prominent legal changes they have affected.

The most important question in corporate governance today
thus is finding the endpoint of the shareholder empowerment movement. Is there
a balance that is both politically feasible and theoretically sound?

I am pleased to report that The Lowell Milken Institute has
authorized me to organize a conference at UCLA Law in April 2014 that will
bring together prominent corporate law scholars to discuss the central question
of corporate governance; i.e., “who decides?” The focus will be on the changing
dynamics in both law and practice that have significantly empowered
shareholders.

I plan to invite scholars working in all three of the major
models of corporate governance currently in widespread use in the corporate
legal literature; namely, director primacy, team production, and shareholder
primacy.

Director primacy is the model I have developed over the last
ten years or so. It attempts to both explain and defend the broad grant of
authority to boards of directors that is at the heart of American corporate
law. It argues that this grant of authority is essential to ameliorating the
informational demands a large corporation faces. The grant of authority,
however, creates the potential for abuse of that authority, creating a need for
accountability mechanisms to limit such abuses. The tradeoff between authority
and accountability is at the heart of corporate law. I propose that a
presumption should generally favor authority, and therefore I oppose most
proposals to increase shareholder power.

Director primacy has been well received as a model of
corporate governance. And I have been recognized as “the leading proponent of
the director primacy view,” to quote J.W. Verret,
Treasury, Inc.: How the Bailout Reshapes Corporate Theory and Practice, 27 Yale
J. on Reg. 283, 321 (2010).

To be sure, director primacy has its critics. Some see it as
normatively unattractive, while others see it as lacking descriptive power. A
leading competitor to director primacy is the team production theory of
Margaret Blair and Lynn Stout. Like director primacy, team production theory
defends the broad grant of authority to boards. However, it draws upon a
different theoretical framework in doing so. Although team production theorists
agree with me on the desirability of granting significant authority to boards,
they disagree on the proper ultimate aims of the board in exercising that
authority. I believe boards should focus on maximizing the value of the
corporation for shareholders. Team production theorists believe boards should
focus on maximizing the net value created for all corporate constituents
collectively.

More importantly, director primacy is strongly opposed by
those scholars who adhere to shareholder primacy, with Lucian Bebchuk as the
most prominent example. Shareholder primacy theorists contend not only that
shareholders are the principals on whose behalf corporate governance is
organized, but also that shareholders do (and should) exercise ultimate control
of the corporate enterprise. Hence, for example, shareholder primacy assumes shareholder voting rights that are both exclusive and
strong.

The debate between these models is widely recognized as
having considerable importance for our understanding of corporate law and
governance. Faith Stevelman, for example, notes that
“[t]he competing claims of ‘shareholder primacy’ and
‘director primacy. go back to the early beginnings of
corporate law.” Faith Stevelman, Globalization and
Corporate Social Responsibility: Challenges for the Academy, Future Lawyers,
and Corporate Law, 53 N.Y. L. Sch. L. Rev. 817, 841 (2008/2009).

The choice between shareholder and director primacy is most
obvious relevant to proposals to empower shareholders, such as say on pay,
proxy access, and majority voting. At present, as Gordon Smith notes, “[d]espite the recent moves
facilitating shareholder empowerment with respect to director elections, both
Delaware and the SEC continue to rely on ‘director primacy’ as a foundational
principle of corporate governance.” D. Gordon Smith, Private Ordering With
Shareholder Bylaws, 80 Fordham L. Rev. 125, 170 (2011). As advocates of
shareholder empowerment continue to press their claims with respect to other
legal issues, however, the pressure on Delaware and the SEC to chose between
shareholder and director primacy will become even more intense.

The conference therefore will be devoted to using these
models to explore the ongoing question of shareholder empowerment.